Ponzi Schemes Are Alive and Well

It’s been nearly a decade since Bernie Madoff was arrested for the most infamous Ponzi scheme in history. But while likely none are as big as Madoff’s $65 billion fraud, there could still be hundreds of similar schemes in operation across the country. And one of the best defences against fraud, regulators and industry lawyers agree, is a licensed financial advisor..

Last year alone 59 schemes were uncovered in the U.S. with alleged losses totalling $2.37 billion, according to data compiled by website Ponzitracker. Jordan Maglich, the site’s creator, said data shows the unearthing of Ponzi schemes has stayed reasonably consistent over the last five years, both in terms of discoveries and the sentencing of perpetrators.

Maglich, an attorney at the Tampa, Fla., firm Wiand Guerra King, started Ponzitracker in 2011 to shed light on the persistence of so-called Ponzi schemes – the repaying of existing investors with the inflows of new victims without actually investing in anything.

Since 2012 an average 65 Ponzis a year have been discovered, with a median scheme size of around $6 million. But last year Maglich noticed Ponzis skewing smaller in assets, to $3.5 million.

“While discoveries remain relatively consistent since 2013, the slightly smaller size of schemes could suggest regulators are doing a better job rooting out frauds before they get too big,” says Maglich, adding that since being criticised for not catching Madoff earlier, regulators have beefed up compliance and enforcement resources.

Both the SEC and Finra run whistleblower programs and complaint hotlines which have been successful in unearthing fraudsters. Both investors and financial advisors alike are welcome to use the hotlines to bring a scheme to the awareness of the regulators.

“In the schemes we’ve successfully uncovered, the investigation has usually started with a victim who’s frustrated they can’t get their money back,” says Cameron Funkhouser, head of Finra’s Office of Fraud Detection and Market Intelligence. “These investigations sometimes don’t require a lot of digging. It can simply be a matter of applying common sense to the situation.”

Hence the need for adequate resources.

Often advertising, seminar material or a website can draw the regulator’s attention. Perpetrators “need to attract victims, so they tend to have some sort of outward-facing presence,” says Funkhouser. This presence is also used to add an air of legitimacy if the schemers do not belong to an investment firm, and to keep victims acquiescent.

Funkhouser says once Ponzi schemes are unearthed, they “tend to unravel pretty quickly,” because they are usually based on simple lies which crumple under scrutiny.

Ira Sorkin (Getty)

Yet highly educated people are often the victims of these frauds. “Criminals target people with money,” says Owen Donley, chief counsel of the SEC’s Office of Investor Education and Advocacy. “The people who run these are often very charismatic.”

The SEC’s consumer-facing investor protection website outlines how investors can identify a Ponzi scheme. It lists several “red flags” which indicate you’re being swindled. Top of the list is the promise of high returns with low risk, or suspiciously consistent returns. “Markets go up and down. No one is consistent over long periods of time. If someone claims otherwise they’re probably lying,” Donley says.

He also warns investors to ensure the investment and its seller are SEC-registered – through the SEC’s site or Finra’s Brokercheck, investors can check the legitimacy of an advisor.

If an advisor is registered as a broker-dealer or RIA the chances of frauds being committed obviously drop significantly. And if a fraud is committed by a licensed advisor, the firms they work for have a vested interest in protecting the investor – and their own brand – experts say. As such, firms will often attempt to help the investor to recoup losses.

Investors also need to watch for complex, secretive, or just plain bizarre strategies. One recent Ponzi promised to make money from the secondary market for tickets to Hamilton, the Broadway musical. In an ongoing case, the SEC alleges $81 million was defrauded from some 125 investors. Another offered investors a slice of securitised loans to professional athletes. The Ponzi was marketed by Will Allen, a former New York Giants player. His co-conspirator, Susan Daub, was an advisor whose Brokercheck record showed she’d left the industry in 2010. Allen and Daub each received a six-year jail term for their deception and the two must pay $16.8 million in restitution.

Donley says investors and fellow advisors concerned about a colleague should also be suspicious of any paperwork problems – such as account statement errors – or with trouble receiving payments or cashing out. This is another reason why investors are advised to only invest with a regulated entity which follows strict compliance and paperwork procedures.

For victims, financial crime is often a double-whammy revealed at the worst possible time. Ponzis are mostly uncovered during extended market downturns as nervy investors try to divest to safeguard savings. When the next bear market comes, watch Ponzi discoveries climb, warns Maglich.

“They only end if the market drops and customers start asking for redemptions,” says Mr. Sorkin, a partner at Mintz & Gold in New York City. “If the market is going down, the schemer can’t raise money. Madoff was only found out when he couldn’t pay redemptions.”

But while many see Ponzi scheme investors as innocent victims, Sorkin – whose career includes time as an SEC staff attorney and senior positions in the United States Attorney’s Office – takes a somewhat less forgiving view. For him, it takes two to tango.

“Some investors probably knew what Madoff was doing. If investors are making money they don’t care or ask questions,” says Sorkin. “These things don’t work unless there’s greed on the other side.”